Nov

28

Take any one of Kora's excellent sample trade systems in SP with for example N0 Classical expectation is 60% winners, T=2.2, max historical drawdown 50pts, avg gain 4 pts avg loss 4 pts, with a million dollar stake; max acceptable drawdown 2%, a one year horizon rather than normal asymptotal assumption. R=risk free rate. Time horizon is close to close one day.

Traditionally one would use 8 contracts to limit loss to 2% on the max loss, or a fraction of .4 of stake.

What is the Optimum f use to achieve max TWR? Also what is appropriate n to compute optimal f: the 3 expected trades in the year, or the 30 over the history of the trade? Assume the current historical volatility in SP of 18. How does f change if vol is 9? Also how does the Vince bounded expectation differs from the classical unbounded expectation over a one year with 3 one day event horizon?

The solution in Vince, Risk Opportunity Analysis, p 171 is a 3 dimensional copula. (Escaping Flatland!). Is there a simple R routine or spreadsheet to compute this? The late Seattle Phil uses max drawdown as the main factor In his allocation formula. I think risk management is the most important aspect of investing.

Ralph Vince replies:

Zubin,

So your criteria, from what you describe, is to maximize your gain over this period of time, all else be damned, withing a given (but unidentified) risk constraint. So you are talking about being at the peak of the curve (there are other points, or paths through the space, for different criteria), and you;re talking about a portfolio of one item.

But you do not know what this one-year future time window has in store for you, and I've found the best approximation for where the peak is to divide the percent of profitable compounding periods (in this case, since you have only one component, a compounding period we can say is the same as a trade) by 2. I won;t go into the math for why this is hte best guess aside from saying it will minimize the price you pay, worst-case, between this best-guess point and where, after the year, the actual point turns out to be. So in this example, it starts out at 60% winners, so

.6 / 2 = .3 ad therefore, the best guess point to use as the peak is .3, asymptotically. But you;re talking about only 3 trades over the course of the year, and since the expectation, if you make one play, is to be positive, then if you were to quit at 1 trade, your f would be 1.0, at two trades, the best guess is (f one play less-the asymptotic f) / 2 + the asymptotic or (1-.3)/2 + .3= .7/2+.3=.35+.3 = .65 and for three trades (.65 - .3 ) /2 + .3 = .175 + .3 = .475

So that;s an approximation, that .475, and that;s how I would arrive at it, absent knowledge of the future. It is a good, robust approximation and mathematically sound. I prefer robust approximations as opposed to the exact mathematical answers based solely on past data

Software for this can be found at Josh Ulrich's R implementation for it. I do not have the link offhand. The paper you cit gives the exact formula for determining the landscape and optimal fractions therein, but that is on past data. In the foxhole looking at tomorrow, or next year, I prefer robust approximations that will mimic what the actual formula might provide.

Next, you need to determine a worst-case loss situation. Perhaps you are going long, and you could use the value of 0 for your worst case. or maybe you have a stop in there, and you can use that plus some ridiculous amount of slippage for worst case or perhaps you are using options, etc. But you really need a worst case situation. Dividing the worst-case dollar amount by .475 will tell you how many units (the same quantity you determined the worst case dollar amount on, say, 1 contract 100 shares, whatever) to have on.

Understand, however, that when this worst-case is hit, you will be hit for 47.5% of your stake! So my point is, I think you need to rethink your criteria as it is unlikely what I paraphrase it to be in my first paragraph here. Perhaps you want to allocate a smaller percentage of your capital to this endeavor such that 47.5% is akin to 2% or your total capital. Maybe your criteria actually has you traversing a path in the landscape this curve in 2D space.

Orson Terrill writes:

Is Ulrich, or anyone, still maintaining quantmod? I still have some code that runs on parts of it, that I'll refactor to save time, but hadn't seen much activity around it.

Ralph Vince writes:

I'm certain there is a robust community around it.

Jan

17

I would note that the short, intermediate, and long-term consensus for inflation are all 2.0% +/- 0.5% — as found in the TIPS breakeven market — and this range has been in place for much of the past decade.

One of the larger risks is the growing interest, and calls for, a higher inflation rate (long time developing). They want roughly 4% (implicitly emanating through price level targets), the market thinks 2% inflation is some sort of magical target (it's not, so to that extent they are exposed to being blindsided) - Maybe 3% - 3.5% will be something that can be done.

Follow John Williams et al at the Fed. They have been, and may continue to be, influencing the future of monetary policy. If you're a bond trader, a decision tree may be useful: One branch is that the monetarists' ideas belonging to Williams et al, and what a shift inflation expectations means (the methods are open?), and other branch is that the current regime continues to "win" (quotes for it is apparent that the forces of technology, and some demographics, are deflationary and have wrestled control of inflation from the Fed).

Jun

22

Changes in prevailing direction in market with respect to time period H, such that H > t, often occur as period t has elements with increasing number of lows and increasing number of highs; often ranges decline, as the median price trajectory tilts over, volume decreases (very related to range decreases). The market is in a thixotropic state, where the market making viscous forces are the dominant presence. Sudden change in trading volume (and log changes in trading volume have a negative serial correlation, so such a thing is more likely than usual) perturb the system to a more inertially dominated market than before. Or: volatility contracts and expectations are harder to hit, and traders sideline, while the few voters left who think they have worthwhile wager battle it out.

Jun

6

1) The tennis pro at the building became a realtor.
2) The fellow who installed my window treatments became a realtor.
3) Hurricane season was approaching.
4) A "ballerina" I knew quite well told me to delay selling my condo until she could take the newly instituted 5 day cram course to get a realtor license for which there was a several month waiting list.

This week I heard from a fashion model eagerly desirous of entering the coin market who had opened up accounts at several shops and was mad because they had a waiting period for her buying of various coins.

The conventions on coin presentations were oversold and standing room only.

Sad I can't hand out a statistical answer to document the froth, but there are many.

1) Control of more than 50% of the coins potentially weakens the security.
2) The leaked ability of the hackers to enter any computer in multiple ways retrospectively.
3) The advent of access to quantum cloud computers by corporations in beta (which means govts have had access longer)
4) The untested nature of the post-quantum algos.
5) The need for the governments to track and tax money flows.
6) The investigation powers newly needed to stop ransom attacks requiring payment of coins to "anonymous" wallets.

Andy Aiken writes:

Possibly some lessons are:

Techies, anarchocapitalist utopians, Chinese elites, even ordinary people desire a currency not controlled by the state, that offers privacy and security without requiring armed guards for a big gold stash.

The financial technology and payment processing systems for USD, Euro, etc are antiquated and slow, decades behind what is feasible and in reach, struggling under a mountain of regulation.

A currency is what people use to pay for things. When the European banking system was in shambles after WW II, people paid for food with cigarettes. Scrip has been used many times throughout history.

Getting financing for a company by working with bankers is an expensive, frustrating experience. Business founders will find a way to cut the middlemen out of the game if they don’t add value.

The cryptocurrency mkt is definitely frothy. As with the dot com bubble, most of the coins & firms will fail. Some will go on to be the future Amazons. These human needs are in search of a solution even if all of cryptocurrency goes to zero tomorrow.

Orson Terrill writes:

Same here, starting about 2 weeks ago, yet again, people are asking me about bitcoin. This has usually coincided with near term top, and has been true since 2012. Same for stocks.

anonymous writes:

I do some consulting in this area, and last week I had a few calls (one from a PE firm) come in asking me for a general overview of the competitive crypto landscape, including who mines, what the pecking order of coins is (in terms of best, most used, etc.) and so on; stuff that could pretty easily be found on the web, by haunting Reddit, etc.

Froth indeed.

Stefan Jovanovich writes:

Thanks to Andy Aiken, I have been able to get some sense of how Bitcoin actually trades. Also thanks to him, I learned - yet again - the most important lesson about trading: you can't claim to understand a market if you don't actually trade it.

I don't trade Bitcoin and have absolutely no idea what will happen to the markets for it. But, it does seem to me that the participants in the markets for cryptocurrencies - whether long or short - are making one assumption that is simply not proven by the evidence.

Bitcoin is not a currency. Neither, for that matter, are ounces of gold. These days a currency is an IOU that

(1) is accepted as a credit for deposit by the banks that are willing to use that currency as a unit of account; (2) is accepted as final payment for taxes and legal judgments; and (3) is the face denomination for the government debts that are accepted as officially-sanctioned reserves for financial institutions

That Bitcoin is not a legal tender has not mattered in the slightest as far as the traders in Bitcoin are concerned.

In the days when money was coin, there was a long history of unofficial credits being actively traded and readily exchanged and even accepted for deposit. The Virginia lawyers who most closely followed Washington as President (Jefferson, Madison) were infuriated by the speculation they saw in New York over the debts that were to be redeemable in the country's new money. They were themselves active speculators, as Washington had been; but their gambles and savings were in warrants and other paper claims on the Western lands. When the people who support and believe in Bitcoin argue that the digital claims they have bought or mined are as "real" than as the digits that represent the vast bulk of people's dollar/pound/Euro/yen/renminbi "money" (sic), they are absolutely right. Bitcoins and dollars are both simply collective promises that what is represented has the value of scarcity and is not counterfeit, and they both have to be taken on faith.

There is only one problem. Governments, as Hamilton demonstrated, have a serious interest in having their official fictions take precedence. The risk of any Bitcoin "bubble" is that, in the name of the protection of official legal tender, unofficial digits may find themselves being investigated for their risks of "fraud". Government can always be relied on to investigate others for having committed the very sins that the government wants to preserve for its own spiritual authority.

Anatoly Veltman writes:

Centrals may investigate and outlaw whatever they wish - but since they've encouraged the vastness of the internet, it's impossible for them to replace the cork. Eventually, they'll be adapters of a protocol.

anonymous writes:

And that is exactly the point.

With crypto there are no groups of individuals painstakingly crafting bills in basements OR shadowy dictators buying eight figure currency printing machines from manufacturing facilities in Bavaria or Switzerland. Even if governments manage to cripple or persecute the Bitcoiners - (who? miners? users? developers? writers? consultants?) - there are as I type this 735 existing crypto issues, over 100 crypto assets, and thousands of tokens trading in nearly 4000 markets of varying mechanisms and liquidity around the world. Far more important than that, each day tens of thousands of new minds are brought into the crypto sphere, some of whom are brilliant programmers both (a) eager to outdo the best of what is currently available, and (b) eager to get rich. There is no, absolutely no, putting the proverbial genie back in the equally-proverbial bottle.

May

27

As long as there are useful idiots in the world like those that I often enumerate from Cal, and the twin former Harvard fund manager, there is no need to worry about A.I in our field.

Orson Terrill writes:

The idea out there that there is no discoverable alpha, or soon there will be no discoverable alpha, because of so many quant funds, hft, AI algos, have absorbed it all…. is ridiculous!

People should be excited that no one can get to it all.

The factorial reality when trying to get the faintest idea of the market as a closed system was already beyond the grasp of current human ability. Attempts to increase precision with AI doesn't remove anomalies from the market at an increasing rate, it will slow the rate of removal. Deep learning adds a huge amount of variables (random weights, nodes, whatever you want to call it) to the computational load.

Say you want every basket of 10 stocks you could make with the SP500, for 10 years of data, OHLC, volume, ranges of various frequency, day of week, day of month, month of year, 1st 2nd 3rd (and on) differences of everything, some various filters such as averages, then you want covariances, the changes in those.

THEN! (Maybe!) You take those 200 octillion data points (seriously) and get to work with some AI? Seriously? Every computer in the world probably couldn't do this, and of course you'd still have over fit models in the end.

To make the point about AI:

Formulating a model, or an hypothesis about a condition, with all the data wrangling and basic transformations involved, that are then used to make orders of magnitude more data by fitting something as basic as a neural network auto-regression model, essentially means the potential combination of inputs, and computational demand, has left the universe. It's way beyond the scale of any computational feat happening even the most bleeding edge. So. Far. Beyond.

In other words, think, dig, have ideas, test them, and don't worry that you might be the only one trading on something. If what you're trading on has just a minutia of complexity, it probably wasn't found via brute force search by some high performance computing juggernaut. Bet on that. They have trillions and trillions of the most simplistic price change anomalies that they are still chasing/racing each other for all over the world.

The stuff that the Chair was doing in the 70s (before I was even born!) is still being chased today…and everything else (which is almost everything) is left on the table. The structural reality of: What computers are good at, returns to speed, large funds needing to focus on the most liquid assets for risk control, and because large funds need larger sources of liquidity to match against, guarantees most money is crowding in the same large liquid spaces.

Stef Estebiza writes:

Warren Buffett's favorite holding period is forever.

anonymous writes:

That is his favorite holding period for everyone else, particularly those holding his, as it reduces the directional liquidity to the upside and therefore reduces the the power of the viscous forces to resist change and increase slippage to the upside.

2. The new guard of bond traders at Pimco is a credit to our profession and their attention to detail in the prospectuses and their emphasis on contrary trading has a pleasant resonance to our own inestimable and dearly departed Mr. E.

3. Every day the market swoons on some contrived piece of news to make the president look bad and create fear and churning and then closes the day at a new high. 64 of the last 293 days since year end 2015 the spu closed at a 20 day hi. Since year end 2008, its 489 out of last 2097 that closed at a 20 day high. It is a testimony to the wisdom of the triumphal trio and our own Williams and Vince.

3b. A 6' 11 inch giant who played for the Knicks and whose father could have a better + - record than the son, is not content to stay disabled and wishes to come back reminiscent in my opinion of Lenny in Of Mice and Men.

5. A simulation of seasonalities in markets shows that there is a non-random seasonality in the bond market but not in stocks or gold I think.

6. When one has a very good hand in poker there is a very much elevated chance that another player has an excellent hand also. This of course is not random but a result of sampling without replacement. However in markets, runs of unusual moves in one market are often followed by runs of unusual moves in another market and this is a non-random regularity. For example, there were 5 red days in a row in Feb, 2017 and they were followed by 5 yellow days in a row.

7. The moves in the German Bunds often foretells the moves in the US bonds. The precious metals takes big positive moves to an inordinate degree around holidays and big announcement days.

8. The bonds like like it when the dollar is up, and the stocks like it when the dollar is down.

9. The ratio of the dax to the S&P stays remarkably close to 5 over time.

10. The stocks to bond ratio at 16 is at an all time high.

11. All news that is favorable to the current administration will be suppressed and all news that is unfavorable will be emphasized.

12. I challenge anyone to read the chapter in Monte Walsh on accounting for cattle profits and the race between the horse riders and the train without crying.

13. Any movie that wins a major academy award will of necessity treat business in a highly unfavorable way and lionize people of color, and will contain indirect negative references to Bush and Reagan to show that they are fellow travelers.

14. The dominatrix beginning and end of the first episode of billions is very dramatic and realistic, but the fight between the agency in Washington and the NY state federal attorney seems contrived as is Axelrod's ability to spot block trades and take short positions based therein. Anyone who shorts stocks that are inside acquisition targets is likely to have a negative return much greater in absolute value than the triumphal trio's results.

Julian Rowberry writes:

A comment on point number 6 about poker: Interestingly this can work both ways as we break down a problem.

If we take a hand of poker, the decisions made during a hand over the flop, turn and river will reduce ranges (possibilities of different hands people can have) players have, i.e. folding bad ranges, continuing with strong ones. Resulting in stronger ranges as we approach the end.

But sampling without replacement will decrease the odds of another player having an excellent hand. If I have 2 hearts in my hand on a board that has made a flush, that is 2 hearts that no one else can have. Which by the end of the hand, where ranges are significantly reduced, there is a very much elevated chance an opponent won't have a flush. When bluffing, in this situation it's good to have one heart, thereby reducing the possible flush combinations opponents can have.

Maybe there's an opportunity with similar behaviour in bonds & stocks? I don't know.

Where a more detailed look involves some behaviour that opposes the stronger over riding behaviour. The stronger overriding behaviour is often more well known and understood. Making hard to remove the ideas out of the boxes we have put them in and think of them differently. Group think markets seem ripe for this type of oversight.

Victor Niederhoffer writes:

Thanks for your erudite answer. Presumably when you have 4 of a kind, the chances that the opponent will have 4 of a kind are improved. There is also the chance that your opponent has stacked the deck. Much too often it seems one has a full house and the opponent has 4 of a kind?

Julian Rowberry responds:

Tricky question, like a lot of things, it depends. Ignoring stacked decks and rake, there is no one size fits all answer. I can give a general answer of why strong hands clashing appears to happen often. ANd much more often than optimal.

The nature of most poker games, we have pros versus 'recreational' or 'fun' players' (that's the modern PC term for fish, sucker, donkey or mark!).

In general, Pros when playing recreational players are are going to fold vastly more than optimally with their weaker holdings early on in the hand. Recreational players are going to continue on in hands vastly more than optimally with their weaker holdings.

This continuation increases the combinations of hands the weaker player can have towards the end. Which increases the combinations of 2nd, 3rd, 4th best hands for the weaker player against a increased combinations of 1st best hands for the pro. So the result is we see more strong holdings versus strong holdings showdowns. Where inevitably the pro wins what's left, if anything, after rake in the long run.

If two pros played each other, it is much rarer to have very strong showdowns from each player.

Orson Terrill comments:

It seems that if you sample without replacement from a disordered arrangement of a well ordered system, and you draw a well ordered hand, then you leave a more ordered system on deck as a result.

The complement of order is not disorder.

I've played poker less than 5 times, but if the combined hands of the prior game were well ordered cards of lower value, and I received a well ordered high value hand, the assumption would be that the same situation for my opponents is even more likely.

Feb

7

The Observatory of Economic Complexity is a tool that allows users to quickly compose a visual narrative about countries and the products they exchange. It was Alexander Simoes' Master Thesis in Media Arts and Sciences at the MIT Media Lab, which you can read here.

Orson Terrill writes:

It's a wonderful example of taking a few concepts, and scaling them beautifully.

Here is a possible meal for a lifetime nested within the same body of work:

"…Moreover, we show that their nestedness remains constant over time and that it is sustained by both, a bias for industries that deviate from the networks' nestedness to disappear, and a bias for the industries that are missing according to nestedness to appear. This makes the appearance and disappearance of individual industries in each location predictable. We interpret the high level of nestedness observed in these networks in the context of the neutral model of development introduced by Hidalgo and Hausmann (2009). We show that the model can reproduce the high level of nestedness observed in these networks only when we assume a high level of heterogeneity in the distribution of capabilities available in countries and required by products. In the context of the neutral model, this implies that the high level of nestedness observed in these economic networks emerges as a combination of both, the complementarity of inputs and heterogeneity in the number of capabilities available in countries and required by products. The stability of nestedness in industrial ecosystems, and the predictability implied by it, demonstrates the importance of the study of network properties in the evolution of economic networks."

Jan

25

Two Professors at the University of Washington are developing a course based on BS detection. The syllabus has some useful reading in the links.

Mr. Isomorphisms writes:

I'm skeptical that professors can teach students how to recognize bullshit. This used to go under the name "critical thinking", which is what liberal education has claimed to teach for a long time.

Education levels are now higher than ever before; is there less bullshit or better critical thinking about it, than in decades past when education levels were lower? Why not?

And why is "big data", among all other bullshit, such a powerful buzzword today?

The Decline & Fall of IBM by R X Cringely has partially answered my questions about why a former economic keystone has abandoned all reason and now churns out cognitive "analytics", which I'm sure we can all agree does not make sense or exist.

"IBM tells the customer what to do, not the other way around" is Cringely's description of the dancing elephant. A partial answer to the obvious follow-up questions is that (as Herb Simon noted 50 years ago) the dynamics of large organizations/ teams are what drive output, not "market" forces as normally construed. Your promotion does not depend on whether the customer likes your work, but whether your boss's boss does. "Cognitive" and "behavioural" are good signals of bullshit.

It's fairly clear to me why Facebook and Google are funding the big-data-analytics-machine-learning movements: They're monopolists with large ad revenues and special share classes; they don't get punished by their shareholders for weird hires (eg, Ray Kurzweil).

There is a compelling case for the self-driving lorry, but really Google X is doing whatever it wants; that one or more of the blue-sky projects could theoretically benefit shareholders at some point is not the reason any of them are funded.

IBM, FB, and GOOG then hire academics who otherwise have no useful skills out of their universities, thus driving demand for machine-learning academics. Since (unlike in traditional scholarship–say the study of pre-Islamic poetry in the Arabian peninsula) having written good papers is less important to GOOG than the ability to commit clear code, and since their screening process is itself derived from academic bullshit (whiteboard exams asking about algorithms & data structures), they create demand for bullshitters with certain characteristics– a pipeline of demand for big-data machine-learning bullshit. See Laszlo Bock in the NYT or Steve Yegge on his blog almost a decade ago. These do not work — but the questions are already written, and everyone else is doing it. That's my personal theory.

Further questions:

- how does university-professor recruitment like the above differ from other examples of industrial research over time — Xerox PARC, Bell Labs, JPL, Salomon, etc?

- when will this all end?

- what will the HBR write about next?

- what "actually" teaches people to think critically?

- are science and mathematics classes antithetical to critical thinking? (I notice mathematicians are incredibly bad at critical thinking. Pascal made a related comment in his 1664 memoirs. Further comments could link Soviet scientism to poor critical thinking skills.)

- why did "big data" and "algorithms" (literally translated: ways of doing things) catch on among all the other kinds of bullshit in this particular zeitgeist? (My answer: we live in a scientistic age where money and technology have replaced religion's former role, eg in providing moral guidance– see for example the prelude to "The Right to be Lazy" )

Pepper White's interesting bookLearning to Think at MIT recounts that interaction with industry is what "makes" M.I.T. a success. Though engineering companies may be bullshitting themselves in this requirement, asking for a higher degree before an experienced engineer can move up in the company drives experienced engineers into M.I.T. as they try to skill up, brand themselves, and raise their salary.

The contact between professors and managers-to-be is what brings real-world knowledge into M.I.T., as well as research money/contracts to do real inventive work for major engineering firms, when the master students do get those management roles.

So, another question:

- why is the interaction between "silicon valley" (broadly construed) and academia leading to "productive" interchange? This book –out of a university press, P.U.P.– mentions a 1982 essay and I'm sure, besides Orwell's famous essay on political bullshit, we can find innumerable screeds against lying and bombast going back as far as we would like.

A salient feature of the analysis of bullshit, to me, is that Universities do put out some of the most informed, solid, truthful, and well-researched books, as well as the bullshit everyone is surely familiar with, be it from finance academics, machine-learning academics, or cultural theorists.

It would be too easy and quite wrong to say that business professors, ML professors, economists, or cultural-theory professors are full of shit–even though we can observe credible causal mechanisms and a wealth of examples of people holding such posts, who are routinely full of shit. The answer has to be more complex.

Orson Terrill writes:

Isomorphisms asked what teaches critical thinking skills. Rigorous symbolic logic with all the proofs, like that seen in any solid discrete mathematics course, and a hard study into philosophical logic, which has much of the same content, but without flowing into set theory, and instead has a hard look at fallacious thinking via the many fallacies.

Isomorphisms replies:

A distinction between "broad logic" and proofs is an important one. Most mathematicians lack common sense (logicians and PLT theorists even more so), and most forms of argument have not been formalised within logic. For example centuries passed between St Anselm's ontological argument and Gödel's formalisation of it within modal logic. Lawvere, an avowed communist, attempted to formalise Hegel over a century after Hegel's death. If you want to argue that proofs make one wise, you'll have to contend
with the inventor of category-theory's communistic views.

The people who impress me with their critical thinking ability often display a study of history (not necessarily a college major or war buff). Some professional anthropologists–Lumonier, Malinowski, Chagnon–have impressed me with their critical thinking. (Although of course academics of any stripe often get sucked into their irrelevant peer-only backwaters. Anthropologist backwaters just happen to be leftward of business professors'.)

Method acting, like art crit, subjects the student to painful critiques of their performance. To advance a thesis, it seems like hitting people where they care–their religion (philosophy class), their pocketbook (trading), their creativity (art & acting)–making them see they were wrong where it really mattered–may be part of the key to improving students' critical thinking. The things that students don't care about–their required essay about some boring book, a proof of a fact/about an object they never inquired about–don't seem to have any impact on the core person.

Trading experience modulates anterior insula to reduce the endowment effect. Trading experience has been shown to reduce the endowment effect, a decision-making bias that distorts market prices and reduces trade. Understanding the mechanisms underlying how experience changes this bias will provide important insights for developing interventions to improve market efficiency. Using functional magnetic resonance imaging, we show that market experience causes a reduction in right anterior insula activation during selling, which mediates a decrease in the endowment effect. These findings suggest that trading mitigates negative affective responses in the context of selling. People often demand a greater price when selling goods that they own than they would pay to purchase the same goods—a well-known economic bias called the endowment effect. The endowment effect has been found to be muted among experienced traders, but little is known about how trading experience reduces the endowment effect. We show that when selling, experienced traders exhibit lower right anterior insula activity, but no differences in nucleus accumbens or orbitofrontal activation, compared with inexperienced traders. Furthermore, insula activation mediates the effect of experience on the endowment effect. Similar results are obtained for inexperienced traders who are incentivized to gain trading experience. This finding indicates that frequent trading likely mitigates the endowment effect indirectly by modifying negative affective responses in the context of selling.

There are basic summaries around the uchicago site.

Jun

17

Orson Terrill writes:

No. Every episode of hyperinflation involved government essentially going to debt markets, spending it all, going to debt markets to cover interest and raise new money, spending it all….each iteration increases inflation, reduces demand for the debt, and undermines the perception of the currency as a store of value (all equivalents in this case). The plummeting value of the of the currency (hyperinflation) is the end game.

Stefan Jovanovich writes:

The German, Austrian, Hungarian and Italian currency collapses after World War I had nothing to do with "going to debt markets" because the domestic markets for private debt had literally disappeared. In each case the collapse of the exchange value of the currency began with wage indexing; payments to government workers and all those covered by union labor agreements were linked to price indexes, and the governments literally printed the money for those increased payments.
There is one part of the suggested parallel to the present that is accurate. The governments "borrowed" the money from the central bank in the same way the Japanese and American Treasuries now cover all current fiscal deficits.

But there was no problem for these nations' Treasuries to "cover the interest" on their domestic debts; while tax revenues fell behind price increases, they were still more than enough to cover the "old" coupon interest charges on the government debt issued before wage indexing had begun.

As for "the plummeting value of the currency" the German central bankers and Treasurer were completely convinced that their funding the government's wage increases had had absolutely no effect on prices; after all, the price level in Germany as measured by the pre-war gold standard had not gone up at all and German exports were thriving! What stopped the wage indexing was the realization that German domestic assets were not keeping pace; at one point, the entire value of Daimler Benz as a company was reduced to the price the factory was charging in dollars for sending 4 of its phaetons to America.

Bresciani-Turroni's book, Economics of Inflation, is essential reading on the subject. The Mises Institute has a PDF; but one should ignore their own explanation by Thorsten Polleit. He refers to B-T's book but does not seem to have actually read it.

Peter Tep writes:

Have you read Martin Armstrong's work? He relates Weimar Germany to previous episodes of hyperinflation, which is just collapse in confidence of government and then currency.

Look at Argentina, well at least few years ago. You could go to the street "cambio" to get better rates than the bank. That's loss in confidence.

Don't mean to sound condescending because you gents are far smarter than me! Doesn't hyperinflation require a high velocity of money?

Seems gold bug narrative is fixed to the issue of "money printing", and I don't know the specifics of how repo market works but I thought QE was a swap of bonds for cash and not helicopter money, hence US velocity of money down due to the banks parking at Fed, or in this case the ECB.

Just my two cents, but an interesting conversation for sure!

Gordan Haave writes:

Stefan, you said "Here in the bleachers we have a hard time understanding the fine distinctions of the forms of central bank lending/purchasing in a fiat currency scheme."

This is by design.

Anyway, it reminds me of art history. When I went to Greenwich High School I spent my senior year in a program called "shapers of the world" which was a western core art, music, and literature program. Then I went to Columbia which had, and still has, the finest western civ core curriculum.

I studied art history for years. One day, sophomore year we were looking at slides in an art history class. I wish I remember the name of the artist and painting, but anyway, it was a landscape painting with a tree in the foreground. One of the secondary branches of the tree was crooked, and the professor said that it was the artists way of rebelling against the conformist society he lived in.

Bear in mind that prior to this I liked my identity as a high-class protestant western civ genius. But, when he said that something clicked. A lightbulb went off in my head that said "you know Gord, this is all bullshit".

Anyway, later in life I studied economics for years and years. I can tell you all the mainstream answers about why creating money left and right is not, in fact, "printing money" as Mr. Tep said above.

However, my conclusion about it is the same as my conclusion about art history. "It's all bullshit".

They are creating money and giving it to themselves to print first, no differently than the way roman emperors called in coins and re-issued the with less silver content.

The rest is all obfuscation.

The key in all of this is not to become a paranoid permabear, but rather to learn to accept reality for what it is and learn to play the game.

Apr

16

The reasons trend following doesn't work are myriad including ever changing cycles transactions costs, and bid asked spreads, the opportunity to game the system against them, and the ease of triggering mechanical rules and the fact that markets are homeostatic, and supply curves change as prices move up or down.

Ed Stewart writes:

In my opinion, part of it is that people who mostly trade their own money look at IRR or "cash on cash" returns, and thus see issues of gains and losses more clearly vs. those who only look at marketing documents and time-based returns of recently hot funds.

Larry Williams writes:

Trend following does not work on just one (or 2, 3, or 4) instrument. Trend followers have to have a large basket of 'bets' on the assumption that someplace in the world a market will trend and that one massive trend—think CL this year and last—pays off the other bets.

It's like betting on all the numbers in Roulette one number pays big odds. Trend followers say they cannot predict which number will show or market will trend, but with enough numbers bet, one will win.

Stefan Martinek writes:

Larry, you make a great point. TF is more risk/exposure management on a basket than trading. Argument that benefits of diversification end after ~20 markets is such a nonsense (my teacher said that too together with other corporate finance theories; they probably never tested anything outside of equities).

Diversification across groups, styles, markets, and time frames improves risk adjusted returns in a long run. Of course in a short run concentration is great - let's bet all on Apple. TF has a nice barrier of entry which is good: First, some money is needed; second, most operators cannot run 2 years without rewards if necessary. They quit. Philosophically it is somewhere between "systematic macro" and "private equity". In PE you expect that most bets will be a crap unless you are in LBOs and other later stage deals. You expect that some areas will be in slumps maybe for years. Patience is such a great thing if one can afford it.

Orson Terrill adds:

Well if I hadn't unnecessarily deleted all of my old code I would just spit out some examples… I wrote several functions that tested trend following, and mostly what was observed was that the number of intervals (days, weeks, whatever) in which a trade would be open generally follows an exponential distribution.

For those that do not know what that implies: Lets say trend "A" has been going for 5 days, the probability that the next day will be the end of trend "A" is roughly the same as if trend "A" were 1 day old, or 20 days old. The next day the probability of "A" ending is generally the same, regardless of its age (like a Poisson process for the arrival of the end). The general notion that longer trends are more, or less likely to end, due to their age, is not backed up.

Just because a run is multiple days old/young does not mean it was profitable. In many markets nearly half of the period's range is traded through during the next period, on average (I think this is true on almost all scales in the EUR/USD, but its been a while). This means getting in on momentum greatly increases the likelihood that a trade is entered at such a point where near term downside is slightly more likely than near term upside (assuming its a long equity position).

There were marginal improvements through adding responses to measures of volatility(mostly changes in absolute ranges), rates of change of price medians from multiple length of time intervals, and most significantly in the general case: reversing intra-trend can garner a couple tenths of 1%. Specifically applying those while using several time series which switch regimes in the sharing of strength of running correlations in percentage changes like SPY, TLT, and GLD, might have some interesting results (I eat what I kill, so I had to leave it there).

Apr

8

A trader at the Grand Bazaar in Istanbul where gold trading has been going continuously for 550 years, amid shouts of 10 whole ones for chocolate tomorrow, a trader in sweats and a wool cap notices my screen, and says "Gold? That's what we love to deal." "Yes," I say, "and stocks and bonds, and oil and grain". "Ah, that's what we love," he says. "Tell us about market trading in the States. What's it like?". I start to tell him but… [where to begin?…]

At 4 am in the morning, a sleepy trader wakes up and finds that prices are climbing. He's short. He looks at the screen and notes they're up 5 points. Thank goodness, he says he saw the price of the stock market on his screen, and it wasn't the bonds he's short… The bond price was a mistake. But then he looks again, and the bonds have risen 6 points. He learns later that day that the minutes of the Open Market Committee were released secretly to 100 politicians and bank officials, on a "need to know" basis and that they were acting on it 10 hours before the release.

The stock market opens down 200 Dow Points, and you buy a line. It quickly goes down another 100 in the first 5 minutes. And you're down a few big. A news flashes across the screen that Janet Yellen just gave a talk to selected Democrats at a closed door meeting, and the market spikes up so you have a 2 tick profit of a grand or two. You quickly get out, thanking your lucky stars that you're not broke, and indeed you have a profit. The market continues to go up, and ends up 400 down on the day, and if you had just held your position you would have been able to retire and pay for the education of all your kids.

You stay at your screen for 48 hours straight, nursing a losing position that's being hammered by instability in Europe. The market is very thin, and you need a big move and big news to get out. Finally after waiting without sleep or food, you go to the refrigerator to get a coffee for 30 seconds, and in that time an announcement that the ECB is stepping in comes out and the market rises to where you would have had a profit, but by the time you get back there's only 2 contracts bid for, and by the time you find enough liquidity to get out, your loss is gigantic.

You're sick in the hospital bed, all wired up with tubes and lines but they're on rollers. A mentor comes from California to visit you to see and comfort the family. You have a big position, and have to trade it. But your ashamed to be looking at at the prices, while he's here to see if you're alive. So you go to the bathroom trailing your lines behind you, and your friend says to your wife, "I guess the kidneys are in desperate shape".

You have a big position in gold, and it's gone against you 100 bucks. You pick up your terminal and you find that Goldman had issued a bearish report on the metal the previous night. Their next report: "As predicted, gold has plummeted to 600. Our prediction was right on target. But we said sell at 800 and it only reached 795 overnight so we missed 5 bucks of the move."

A lot of people have asked me why so many hundreds of thousands trade short term in America. Almost all of them lose. Almost all of them base their trades on mumbo jumbo things that are completely random. The only constant is the vig they pay to the house, which is often 25% of their average gain or loss on the trade. The chances they'll end up a winner is less than the parts in a warehouse spontaneously assembling themselves into a beautiful girl.

I asked an eminent psychologist who has written many books on the market about it. And he said there is a feeling here that no pastime is good unless it causes pain. Most of the traders feel guilt about their childhood, and what horses asses they were and what evil thoughts they had. They wish to atone through trading where the pain of a loss is infinitely greater than the rare occasions that they make a comparable profit. I don't know enough about psychology to know if he's right, but as I suffer through the trading year, and take our small profits on every big move in my favor, but lose it all in the few big moves against, and the little woman says, "when are you going to learn to cut your positions by 90%", I think he may be on to something.

A trader from South Africa comes to your office, and says he's been following your blog for years, and you're the one person in the world that can appreciate his methods. He says he has an IQ of 190 and was on the Olympic handball team. He has the ability to predict the exact range of the day in every market. But his marketing firm won't let him trade unless they execute the trades for him and he wants you to back him. You tell him that being able to predict the range is useless for making profits as far as you're concerned. He leaves the office, curses you out and says he'll be throwing mud on your well deserved and soon to be utilized grave.

A weather forecaster is introduced to you at a party by a friend. He informs you that he's been able to forecast correctly a month in advance the last 7 major droughts in the Midwest. He wants you to subscribe. You ask him why he doesn't just make a killing on these things himself. He informs you he would but he was caught big in one of his forays and lost his stake.

An expansive trader who knows stocks and bonds but knows nothing about the grains decides to take a position in soybeans. He buys a few hundred contracts at the market before the open, and it opens limit up and closes limit down. He finds that he didn't get out before the delivery notice, and his broker informs him that he's now storing 10 big train loads of soybeans in a warehouse at a charge of 10,000 a day + interest.

A trader opens a position in a short put spread selling 20,000 of premium. It goes in his favor for a few days, and it's 15% away from his higher strike price and potential loss. He checks with his broker on the margin and finds that he has 1,000 of premium left but the required margin is 1.5 million. He calls up to find if it's a mistake. "No, that's correct, during the last 3 days before expiration, we assume 10 scenarios, and take the worst which in this case was an immediate 30% decline in price. Furthermore, we're charging you 5,000 a day in Exposure Fees, to compensate for our extra risk. And yes, we just doubled our charges, because we got hit for a 300 big loss on Swiss franc positions, so don't complain."

The lone trader does his analysis and doesn't worry about being taken because he is just one guy trying to make a few trades. And then his setup happens and he takes his position…and the market does exactly the thing that will cause him the biggest loss. How can this be? he thinks. He is just one clown trying to clip a few ticks or points, here and there, not worthy of being a target. But he starts to suspect that maybe he is just one of a thousand clowns, or ten thousand, who are all doing exactly the same analysis at precisely the same time and taking the same positions, which are exploited by a better algo in a co-located box somewhere with huge backing. This "thousandth clown theory" starts to gnaw at him, makes him doubt.

Orson Terrill adds:

An investment bank with operations in Houston hires an MBA from one of the most prominent business schools in California, he's also the son of the CEO of one of the largest banks in Latin America, and surely there will be huge deal flow for them. They put him on with great access and freedom. Instead of putting on a bad trade of several hundred thousand, he's able to executes several hundred million, accidentally, and loses several million in the first day. He ends up being a high paid restaurant manager, for his financial acumen and pedigree, and he sets the place on fire.

Feb

11

Everyone has to sleep at some time or another, even when you're watching the market for that move to your price. You can't leave a limit because an announcement created quantum jumps so you have to watch it. But guaranteed whenever you doze off the price will move right to your desired level, and you'll miss the price.

Closely related is the law of friends and parties. When you're invited to go to a party and accept you would have made a fortune by staying and trading. When you decline to go because you need to trade, it will be the best party ever, and you would have seen the most attractive others ever and they all were talking about how they wanted to meet you, and you'll lose a fortune in the market by trading.

We all know the law of friends, and it's just too bad that whenever you invite a friend to see you trade, you lose a fortune, and he goes back thinking you're a robot wasting your time on mumbo et al.

Orson Terril adds:

When in school I had an account with one of those forex online bucket shops, ran up ten fold in a short time….it was exam time and I fell asleep from exhaustion, only to be awoken by alarms from my cascading margin calls. Good experience.

Dec

17

In Codes of the Underworld: How Criminals Communicate, he mentions that since criminals find it very hard to communicate directly they often take their signals from vivid events and happenings like in The Godfather which is their favorite (by the way, Puzo had never met a gangster and wrote the book completely from transcripts). They adopt the language and the styles and the activities.

The top feeders in our field have a similar problem. They can't communicate their actions directly as they would be front run and also the public would not be able to weaken and succumb to give them good fills. So they wait for vivid events like today to do their stuff, first clearing the action to make sure there are no others around to intercept their messages. The horse's head was yesterday, but today FOMC was the massacre of bears.

Ralph Vince writes:

The best bridge is played before the first trick is.

Orson Terrill comments:

What about the ECB signaling that next year is when they'll stimulate. Was that a "FOMC, we know you're tightening to some degree soon, and this time we want to lag behind in the interest rate cycle, to get a relatively weaker currency"?

Dec

5

With the price of oil down from 120 a few months ago to 66 today, what do the energy boys on this site think about the prospects for oil and oil industry in the future, near and middle. I am interested in a forecast for the next 3 months particularly.

Gordon Haave writes:

Mine is that oil will continue to collapse. The whole boom was a creation of the commodities index industry and it is starting to unwind and also nobody gives a shit anymore about the Americas and Israel's wars.

Orson Terrill writes:

Sorry about the delay, quite busy, we're planning to take advantage of a slow down.

Saudi Arabia is the Fed in oil. Don't fight them. They said 50% of production in TX would be effected about a month ago. That was a promise not a description. The models I've used suggest we are getting close to that.

It is not far fetched that TX WTI production is showing signs of leveling off in 3 months.

Crude rough models (double entendre) for TX suggest that WTI Production should be down by at least 25% or more in 18 months given current prices, the initial production curves in TX relative to the price of WTI, the decline rate, and the total cost completing a well. I can go back and find the work I did on that, if someone wanted to take my back of envelope work more seriously.

Re-pressurizing presents a threat to that drop in production, but there is some evidence that zipper fracturing is reducing the returns to re-pressurizing wells, which is an expensive process. They can merely stabilize the well, pack up and come back later.

Given that most tools and equipment are leased, the land is leased, the well is drilled by contractors, and it can be done in 30 days…. The short run price elasticity of supply for land based shale plays is very high; they can just send everything and everyone one home, and wait.

The larger companies own rigs; EOG owns about 22 rigs in the Eagle Ford (I use EOG as a yardstick to measure others with).

That is what might catch people by surprise. Just how fast they can and will stop, and how quickly the production comes down to the extremely high decline rates (45%-90% in the first year, roughly 50% in the second, and 30% in the third).

FACT: drilling is slowing down already. FACT: The two merged companies are demanding less of certain services related to drilling. FACT: EOG is one of the, if not the best company in TX at drilling in these complicated shale formations; at these prices many of their wells will not be profitable. I know that is true. FACT: CHK wanted to unwind their aggressive push towards gas under the last CEO, and has been pushing hard in TX for Oil…. The wells they developed in the summer were more expensive than EOG's in the summer. EOG averaging about 6.7 million a well in total cost, it looked like CHK was closer to 8. They need to get initial production rates of twice the average to make sure they are doing better than breaking even. FACT: Saudi Arabia said they believe about 50% of production will be affected by the current price. On Speculation: I advised that was as a promise, not a description of the price at the time… and sure enough OPEC, on Thanksgiving, was not good for TX.

SPEC: I think that its just the beginning for the oil field services companies, because there are some planning and services that go into drilling a well, cementing, fracturing, re-pressurizing, plugging and abandoning.

SPEC: The oil field services that have heavy equipment which is rented out will suffer proportionately.

SPEC: Some E&Ps may generate huge cash flow as they substantially reduces CAPEX on new wells,relative to the next year of flowing oil…

Dec

5

Why does the Fed have a mandate to insure 2% inflation. Perhaps the better question is who benefits from inflation. The average Joe 6pack has no savings, rents an apartment, leases his truck, owns no assets, no stocks. He gets his paycheck and spends it. He wants lower prices. When gas goes below $2 he's happy. When beer goes down he's even happier, and the more he drinks the happier he is and the more he saves. Who wants higher inflation? Big debtors. Who is the biggest debtor: US govt. Who has the most assets at the most leverage: Big banks.

Orson Terrill writes:

I disagree with the Feds own explanation, and I think many economists would too.

The Fed doesn't have a mandate for any target rate, and the dual mandate puts employment at odds with inflation. Their stated concern about falling wages is disingenuous.

While they talk about falling prices, the fact is that the Fed is powerless if rates hit zero and deflation persists. The Fed wouldn't have control over the money supply or the economy. Though there are experimental tools that could be used.

The Fed will never say they are powerless. That creates a game theoretic situation where in deflationary panics The Fed could lose credibility in the markets, and deflation with rates at zero could become a Suboptimal Nash Equilibrium.

Why 2%: There's not really a good reason, and what the the Fed published is moronic….

Theoretically, you can have very stable 10% inflation target, and life would be no different than at 2% inflation target, because REAL prices would be same, so as long as inflation expectations were stable. Most monetary economists would probably agree with this….

Gordon Haave writes:

There are two things going on here really:

The first is the idea that price stability is a good thing in that it aids in long term decision making. The most important point though is the fed view that deflation is a bad thing. The origin of that line of thinking is the Keyensian notion that the market for labor doesn't clear because wages are sticky.

To elaborate: Classical economics would dictate that you would never have ~25% unemployment because the price of labor would fall until it hit equilibrium. However Keynes said that during the great depression this did not happen because wages are "sticky". Due to contracts and other things the price of labor does not fall. Hence, to reach equilibrium the government needs to stimulate demand. There is at some level some amount of truth to the "Wages are sticky proposal" however the cure is much worse than the diseases. The primary policy of both the fed and the federal government is to prevent markets from clearing at all. Hence, when homes are overbuilt and a crash occurs the powers that be actually think that building more houses is a good idea.

The reason for this is the second reason why the fed targets 2% inflation: The idea that deflation is a bad thing. Main stream economists believe that if the economy enters a general deflation that it will enter a "deflationary spiral" where prices will keep going down. Under this theory nobody will ever buy anything because why would you buy something if you know the price will be less next year?

A funny thing is that the Keynesians like to scoff at "Austrians" and other free market theorists for having ideas that don't hold up under scrutiny yet the deflationary spiral nonsense is easy to examine.

First: We know that flat-screen TV prices have gone down every year for the past 15 years. Yet, is it the case that nobody bought them because everyone knew that they would be lower the next year? So, with that one example alone we already know that the entire theory is bogus.

2nd, the deflationary spiral theory poses that basically there is no way out of it. Yet, society still exists as a whole despite many bouts of deflation, so we know that the markets have a way of righting themselves.

This entire theory explains the seeming disconnect between GDP numbers and how the average person sees himself in the economy. In order to keep housing prices up, for example, millions of homes were being built due to false price signals by the Fed while millions of homes sit unoccupied. Everything is being done to keep markets from clearing.

When markets are not allowed to clear and prices not allowed to fall what you get is what currently exists in Japan - the death of civilization as young people, priced out of marriage, home ownership, children, etc. simply check out of society. It is coming here.

Jul

24

Pure random sequences are difficult to artificially generate using computers or algorithms. Some random number generators use natural phenomenon, such as a flame to generate a random sequence. Looking at the ocean waves, or sand dunes it is fair to think of the patterns a being random in the sense one cannot predict where a particular peak or valley will be at a particular time and place. Sailors know this all too well. However, there is an underlying process with its own set of internal rules that generates the the so called random pattern. For waves it is the dynamic between wind, the water surface and the water surface tension and viscosity, the length of the fetch and speed of the wind. Even with such a seemingly random pattern it is possible to predict certain aspects of wave generation such as size, direction with information of the wind speed and direction and duration. Applying the idea to markets, if one could identify the underlying functions would it not be possible to have some predictive ability on the wave size, or in markets volatility as to size time and place as is possible in wave prediction. The navy and NOAA has spent considerable sums on creating models for waves as it is used to time war attacks, landings, how it affect shipping, oil rigs and other industrial needs. Weather prediction is one of the main forefronts of computer science and modeling due to the large number of people affected, and the risks of life and property. Surfers happen to benefit being able to quite accurately predict waves, timing, arrival and size.

Jeff Watson writes:

It is much more difficult than one would think, to generate truly random numbers.

Gary Rogan writes:

While there is no mathematical proof, as far as we know the digits of pi while of course truly deterministic also form a truly normal distribution.

Orson Terrill writes:

How would that be? It seems to me that the 10 digits (0 to 9) would merely have an irregular distribution for any stopping point, but would approach the same number of observations as the number of digits observed approaches infinity. Therefore, the digits would form a uniform distribution, no?…

summary(piVector)

Min. 1st Qu. Median Mean 3rd Qu. Max.

0.000 2.000 4.000 4.443 7.000 9.000

691 decimal points.

Mr. Isomorphism writes:

Getting arbitrarily long Ï€ is pretty easy with the Berkeley Calculator.

It's unclear what a 'normal distribution' of digits would mean, since the normal is defined on [âˆ’âˆž,+âˆž] and most of its mass is between [âˆ’3,+3] … it's not defined on {0,1,2,3,4,5,6,7,8,9}…. I think that Ï€ is actually a normal number, which means the digits are distributed uniformly.

Another nice artefact of using bc -l is that with obase=2, obase=16, etc one can play with the question a bit more, as 10 digits is not sacrosanct. The binary expansion of pi

11.00100100001111110110101010001000100001011010001100001000110100101

should have a 50/50 distribution of 0's and 1's if the decimal digits are evenly distributed, and higher bases (imagine base 12837687622234) would count what appear as "longer patterns" in base 10. I believe it's this way of thinking that leads people to say eg the works of Shakespeare are encoded in pi.

Jun

11

The Constructal Principal where all flows move to the most efficient and point of least resistance and the prevalence of round numbers, one believes has a certain comity and unified cause to it. The question is, is it predictive as well as descriptive.

Gregory Van Kipnis writes:

It is macro descriptive, for sure, and it's micro predictive if you have enough information. In personal discussion over the past few days with sports analysts, everyone agreed on its relevance to predicting outcomes in football and hockey (probably other sports as well). If you study the teams, their bio-physical make up and their play strategy (spreading out vs bunching) you can pick the winner with high accuracy. As for markets though, so much is invisible. To understand and predict each event's outcome so much has to be divined.

Orson Terrill writes:

The options volume and open interest clustering at rounds as a partial explanation is good, and also reinforces the idea that there is a structural preference for the round (the standard strikes). What the Chair says about there being a point on the battle field where doves fly so both sides can come to agreements, and get their needs met, is also an excellent nuance that is worthy of consideration.

When I was taking game theory in school, with a Harvard educated game theorist, the Chairman's round number observation was always on my mind in that frame work; there are multiple scenarios(games) that can explain many situations in markets, and make a prediction if you have the information (what van Kipnis said).

SolarCity Jan 2016 Calls

The 10 rounds are ~35% of strikes, but account for ~75% of the open interest.

Column 2 is open interest, column 1 is the strike (rounds are highlighted).

Apr

21

One of the most astute economists I know who often speaks at the Junto, has described the humorous grandmother as an agrarian reformer without the agriculture. Even worse than the crook that was her chief competitor for the job. One wonders if this is bullish for bank stocks and gold?

Orson Terrill writes:

She just may be the grandmother not wanting to put the son, who has been living in her basement for possibly too long, out on his own two feet. For this person to remain consistent, inflation should be less of a concern than creating a recession to avoid it, and there has been weight in some academic circles that inflation rates need a much higher target (4%). After the attention they've received in the last few years, it's easy to believe they wouldn't want the appearance of interfering with elections. In that light of all that, it would be more or less of a surprise if there was any substantive action, after the tapering is over, until elections were finished. That would give them a year after tapering was completed to have talked about increases in rates, tri-party reverse repos, permanent MBS positions, and maybe how the only bank prop trading allowed, thanks to the new rules, will be in government debt, which carries a 0% risk weighting, therefore, does not reduce capital adequacy…. and how all of this somehow may curtail the effects of reducing their large positions on the most volatile end of yield curve.

But for Massachusetts Institute of Technology professor Sanjoy Mahajan, street fighting is a perfect analogy to encourage his students to use educated guesswork to solve math problems in the real world.

"In street fighting, the beautiful form of a kick doesn't matter," Mahajan said in a phone interview with the Star. "What really helps you is if you connect and get results you need and survive. You can think of problem-solving as being in a duel with nature. You want to get to the end. The beauty and the elegance of it doesn't matter."

In his course, the "Art of Approximation in Science and Engineering," Mahajan, associate director for teaching initiatives at MIT's Teaching and Learning Laboratory, wants his students to use a variety of principles or ways of reasoning - everything from analogical to pictorial - to come up with solutions.

Mahajan believes essentially the students have to lower their standards - a hard thing for any educator to utter and even harder thing for perfection-wired students to embrace.

"They have been trained that science and engineering is all about rigor and exactness. And yes, it is at the end. But at first you need a rough idea of where you are. You need to lower your standards and get something on paper."

Mahajan believes that if students focus on rigorous exact formulas of mathematics, they'll never come up with solutions. "Life comes at you with roughly stated problems," he said. And "you need rough answers."

He often encourages students to draw a picture of why something is true and then they can usually apply the answer to a harder issue. "Our brain is more developed visually than symbolically," he explains.

He also advises his students to find a simpler version of a problem they're trying to solve and try to solve that first. Once that's done, the student can apply the answer to the larger problem.

Another technique he said students can use is "the divide and conquer" form of reasoning. "If you have a hard problem, divide it into bits," said Mahajan. "Like the British ran their Empire."

Mahajan says the key to street-fighting math is to be intuitive and adept at understanding how equations work in the real world.

"You can use these techniques to explain interesting things about the physical world," said Mahajan, who was born in England, grew up in New Jersey. He went on to study physics at Stanford, then mathematics at Oxford University. He did his PhD in theoretical physics at the California Institute of Technology and post-doc work at Cambridge University in England.

"I wish everyone would learn math this way."

In an attempt to share his theories with the world, he has written a textbook for his students and anyone else who might be interested. Street Fighting Mathematics: The Art of Educated Guessing and Opportunistic Problem-Solving is published by MIT Press but is also available online, licensed under the Creative Commons Non-Commercial Share Alike. That means anyone who is interested can download it for free and distribute copies of it as long as they don't sell it.

Orson Terrill writes:

I totally agree with this guy. Progress shouldn't be a prisoner of perfection. When I traded my first algorithmic "system" in currencies, I did not have the privileges to automate my trades with my currency "broker" (often they take the other side on paper), nor the funds to get a real intermediary (I was in college while supporting my teenage brother). Keeping two separate computers running, I had my right hand over my ten-key to an excel workbook, and my left middle finger on the key to take the bid or ask. Often, I would only get the initial figures into my excel sheet, and then "quick and dirty" my way forward for a few minutes. I was still able to put a large number of trades lasting less than a minute, and many that were only a few seconds (it depended on market volatility). The approach was to scalp after a relatively large move began to pause, and depending on the time of day, it could be unreasonable to expect scalping opportunities to remain for long (though they could before an important announcement, or as traders battle each other over the significance of whatever line in the sand has formed, or both).

It is true that much learning is sacrificed at the cost of the perfect learning of formulas that are usually only a model, or an impression, of what happens in the real world anyways. If you're hoping that a price model can be generalized, a holy grail, then it is almost certain that the conjecture will need be formulated with liberties taken.

Craig Mee replies:

Point taken. But though you can win a scrappy dog fight, and the numbers are all quite correct in the excel spread sheet, for longevity in this game, I'm all for finding form and beauty. If you can fight day in and day out and keep your head above water and do ten years and kill it, good job, as in, job done. But to fight every day, and not suffer long term brain damage, I think, is tough to ask.

Mar

23

It is interesting to note that Alfred Cowles the founder of the Cowles Commission, and author of the first good empirical paper on stock market variations, and son of the owner of The Chicago Tribune, in the early 1900s, is a forgotten man. No bio on wikipedia or mention on google except for his father exists. Like Sloane and Kettering at Memorial, the denizens of the institution he founded seem to be ashamed of him. I corresponded with him when he was 70.

Orson Terril writes:

This is a song from a skit that junior researchers performed in the 1950's:

"The Cowles Commission was featured in this one, to the tune of "The American Patrol" march:

We must be rigorous, we must be rigorous,
We must fulfill our role.
If we hesitate or equivocate,
We won't achieve our goal.
We must investigate our systems complicate
To make our models whole.
Econometrics brings about
Statistical control!

Our esoteric seminars
Bring statisticians by the score.
But try to find economists
Who don't think algebra's a chore.
Oh we must urge you most emphatically
To become inclined mathematically,
So that all that we've developed
May some day be applied!

Its exact authorship is surrounded by a certain degree of obscurity, which perhaps is just as well."

Little late here, catching up. I would like to echo our underwriter's points by expressing my surprise that there is not a single entry of Alfred Cowles on the wikipedia article for the Cowles Commission. This is worthy of surprise because, as was alluded to, the Cowles Commission is also now the Cowles Foundation. Titans of economics like Nobel Laureate Robert Solow, whose growth models are given a thorough workout in any intermediate or above macro-economics course, were funded by the Cowles Foundation. Robert Shiller is a researcher there. If he, and others, are worthy of a Nobel according to those who make such decisions, the namesake of his underwriter is certainly worth a mere wikipedia entry.

Feb

28

Everyone should be extremely skeptical about the meaning of "buying". While selling is selling, buying generally includes, and therefore is completely dominated by, receiving stock compensation. Unless someone is going through all of the Form 4 filings with the SEC and determining the transactions are coded as private transactions from insiders, meaning they actually ponied up their own money for the shares (was it required they buy them for be on the board?), then general "buy" as form 4 filing is pretty much meaningless. Also, the turnover of shares relative to the number constantly held is important. Some insiders might have what look like large holdings, but when you see the shares come that are coming through from compensation that are being dumped in large volumes all the time it can make one wonder if the holdings are just window dressing, and insurance against regulatory actions ("I had so much wealth with the common share holders").

Jan

17

Just look at how they continued to reduce treasury holdings right into the crises. They were talking about complete collapse while shelving monetary policy and changing their approach to legislative. It reminds me of the HFT firms who provide large pools of liquidity, but unplugged their systems during the flash crash.

Dallas Fed President Richard Fisher said Tuesday he wanted the taper to be double the size it was — in other words, $20 billion instead of $10 billion. The Fed is still buying $75 billion worth of Treasurys- and mortgage-backed bonds each month. "But the important thing for me is that the committee began the process of slowing down the ballooning of our balance sheet, which at year-end exceeded $4 trillion. And we began-and I use that word deliberately, for we have more to do on this front-to clarify our intentions for managing the overnight money rate," he said in a speech to the National Association of Corporate Directors. Fisher, who this year is a voting member of the Federal Open Market Committee, stressed he would "not flinch" from continuing to reduce asset purchase even if a stock market correction were to ensue.

Dec

16

1. In 2003 companies were given safe harbor from being accused of manipulating their own share prices so long as they had a proper share repurchasing plan. In 2004 they were double the dollar value of 2003, and by 2007 total dollars on repurchases had grown 7 fold to its peak (2012 is still nearly 5 times the 2003 figure).

2. Companies buying back their shares are reducing 3% of their shares outstanding, and it is supposed to be more than 4% reduction next year.

3. There is clear evidence for firm specific seasonality of buybacks. One example: In the fourth quarter, AutoZone (AZO), repurchases more than twice the average of the previous 3 quarters, and they do this every year. This is because the 4th is their highest earning quarter, and they want to finish the year with an EPS growth bang.

4. Be watchful of firms that have large buyback plans, and executive compensation based only on share price and EPS. AutoZone goes on and on about operational efficiency, and new loan facilities for general operations; its completely obvious that most of the debt is for repurchases, and the EPS growth is mostly from those repurchases. They never put it center stage…why?

5. The SEC sees using repurchases to "manipulate" earnings as a violation of the law, while at the same safe harbor can be obtained relating to price manipulation. How they separate the two is baffling; "manipulation" is dangerously vague, and many firms may get aggressive at their own peril.

6. Treasury shares are not the only place shares can go to. A very dubious dark hole on a balance sheet: The SEC interprets the law as shares repurchased do not have to be shown in treasury shares, disclosed on the balance sheet, or earnings statement.

7. From the SEC website, "Rule 13d-1(a): In calculating the number of outstanding shares, shares repurchased by the issuer to fund a stock option plan are not considered to be outstanding even if the shares are not retired or put in treasury. Section 13(d)(4) of the Exchange Act provides that the class of outstanding shares will not include shares "held by or for the account of the issuer".

8. This doesn't only apply to shares repurchased for stock option plans. Here is another from the SEC website:

9. "Shares that an issuer repurchased do not count as outstanding shares, even if the issuer did not retire the shares or account for them as treasury stock. Section 13(d)(4) of the Exchange Act excludes shares "held by or for the account of the issuer or a subsidiary of the issuer" from the class of outstanding shares. [Sep. 14, 2009]"

10. Looking at AutoZone's total share repurchases, it's easy to tease out that they repurchased over 500,000 shares from their stock option programs over the last year. That number is hidden though, because their repurchasing program is so large. The company essentially spent around 250M dollars repurchasing shares from executive compensation. You can't get that number from the balance sheet, income sheet, or other filings (I've looked very hard at this company).

11. It is supposed to be more difficult to re-float shares without notifying shareholders, or getting approval, since NYSE got rid of the "treasury share exclusion". However, if the shares are hidden away in a compensation plan which had been "approved" by shareholders those shares can float. Example next.

12. Again, picking on AZO, because that is who I know well: They have multiple compensation plans and there might be around 26% of their total market cap tucked away in various share programs. You have to look very close in multiple filings over time to get a picture of it.

13. The IRS recognizes the cost of compensation with the options are actually executed: if a repurchase plan pushes shares high enough over the period of years until the are executed, the company can write up the cost of compensation and recognize the cash flow from taxes in the current period. If you push up the stock price enough, you can recapture all of your executive compensation "costs" (cost of dubious option valuations, see next) in cash flow from taxes in future quarters. In 2011, AZO received 6% of their net profits was equivalently this cash flow.

14. It seems unlikely that any company values their stock options for compensation under the consideration that the company will be buying back half of all outstanding shares over the next 3, 4, or 5 years. Think of the firm which has given the executive suite only two targets, EPS and share price, while authorized a repurchase plan large enough to hit those targets on their own. It is not a stretch of the imagination that regulators could come to the conclusion that companies are understating that they can, and do, affect their share price.

Therefore, the economic benefit of the option award is not only more in dollar value (above the strike) than what was recorded as cost of compensation, but it is more likely to be executed than what was input into option valuations. The result could be seen as an intentional understating of the cost of compensation, while using buybacks to guarantee management targets are hit, options are awarded, and exercised well into the money.

15. Firms that repurchase their shares, as a whole, are outperforming market capitalization indexes partially because when their stock prices increase, the change will be larger than the change in market capitalization by basic math. Look at AZO, which has seen its share price grow over 5 fold, while their market cap little more than doubled over that same time period.

16. Likewise, if demand for some equities is partially, or entirely, being met by issuance of shares, those firms will increase in market cap more than than their share price.

17. Many companies are supplementing, or forgoing on dividend programs with buybacks

18. Following that logic, "Dividend stocks" as an asset class might need a modernization; depending on the truth value of the previous two claims.

19. A company can avoid "diluting operations" by pursuing buybacks; as opposed to the core operation's impact on the bottom line being watered down by chasing capital investments, or acquisitions with decreasing marginal returns. I haven't heard anything about this point of view.

20. Seemingly valid EMH critique: "In the longer run, a relative reduction in reinvestment, new investment forgone, or both, should result in a relative reduction in future returns, which in turn should relatively reduce the value of shares". This is true, if the expectation has to be that the returns foregone are of greater magnitude than the reduction in shares outstanding. It's easy to see that 10% less earnings over 11% less shares is relatively better for the people still holding their shares.

21. Additionally, humans, and many other living creatures, discount the future exponentially, or hyperbolically. We'll discount the potential longer run costs of substantial share repurchases if those repurchases are timely and of a magnitude into the future to negate the discounted opportunity cost.

22. If buybacks are accelerating and are not disclosed until each company's the quarterly reports, how are major indexes keeping up with that data, and why is this not an opportunity to get in front of ETF and other index matching funds (some funds rebalance annually)?

23. The opposite works for loss making firms: A company can give a positive trend in negative EPS simply by floating more shares. -$10 per share turns to -$8 per share simply by floating 25% more shares. Firms like this may appear to be on a positive EPS trend, while doing it a "cheaper" price.

Nov

5

Apple is hardly worth the hair splitting, and here's why: First compare Apple's market capitalization performance to their stock performance. The executive culture there looks like they will be getting paid via stock hold dilution for a long time; considering they are also hoarding incredible amounts of cash from shareholders… that's not a pretty image.

Apple is Hollywood, Google is Silicon Valley. Apple doesn't innovate. They sell the sizzle not the steak. They had an idea (the guts) for a larger phone when everyone was going smaller; creating efficiencies from more integration between software and hardware meant they had a solid 2 year lead for a comparable product. We can romanticize the qualities of manic CEOs, rightfully, but when we do, we lose that these basic plays are what really mattered.

Now its Over. Every idea they've had in the last decade is the same idea in different sizes. Furthermore, as the net gets faster, computational devices will "hollow out". There will be less native software, AND hardware. There is going to be less physical product to compete over/with (per item, not in total). Design will matter more; this part of the story is Apple's bright spot: Lexus not Toyota.

Of course Apple's stock is undervalued. Even if Apple came out with products that doubled their sales, there are diminishing returns in the stock itself. That is the nature of mega-stocks, is it not? The rules of diversification ensure that money managers are unlikely to generate the demand necessary to make them expensive, even when they have substantial growth. Consider the structural problem: If Apple were to run to 1 trillion in the next year (100%), that would be equivalent to nearly 30% of Gross Private Savings, yet their stock would have only doubled. Do you honestly believe it is "likely to very likely" that Apple could triple or quadruple in that time period with that kind of constraint? That would take $500 billion- $1.5 trillion in value from somewhere else; relative undervaluation would become more common amongst other companies. At this point, for a medium term speculator it is probably best to buy a Jan. 2016 $500 call, and sell a $600 call for the same month to fund your venture.

Feb

24

Kindly advise Uncle Howie that he is more than welcome back from his Lakers odyssey now that the Knicks have suddenly become relevant again. The modern NBA is a two-star game in a five-player sport. The Knicks now have their two stars, all of which now puts Mike D'Antoni on the hot seat as his Croesus roster just ran him out of excuses.

Howard "Uncle Howie" Eisenberg responds:

People forget about how great Billups is. He was the heart of the Pistons teams that got to the NBA and Eastern finals annually and then lifted the Nuggets from mediocrity (even with Carmello) to the West finals. He is a 90% foul shooter, superior 3-point shooter and great in the clutch. The Knicks are a 3 star team! They should be competitive with anyone– except the Brooklyn Nets who will augment Laker castoffs Farmar and Sasha with all of their #1 draft picks and the rubles of their Russian owner.

Aug

16

I would like to clarify that "congressional acts" have been restrictive on the money supply. Read the first two sections here on excess reserves .

All the new debt issued by .gov is counter productive to QE, proportionally.

The Fed is far from running out of ammunition. One example is that a change to this act, in the wiki article, could remove the incentive for banks to store excess reserves at the fed. This would likely force this $800 billion into other assets.

More importantly:

On the subject of being optimistic I would like to remind anyone to study the important components of any decent growth model (the importance of the idea that is total factor productivity from the Cobb-Douglas function, the Solow model, the Romer model). For the very long run, the Principle of Transition Dynamics can provide a patient simpleton with riches. Generally speaking the fastest growing nations will be those with the lowest per capita GDP relative to their ability to acquire capital, investment, institutional reforms, and education. That has been true for a very long time, probably all of human history, and I can find no reason that it will not continue.

It is commonly stated that China has been the wealthiest country for 15 of the last 18 centuries. According to the McKinsey Quarterly, Africa (yes Africa), will have the largest labor force in the world by 2030. Vietnam and many South Asians are reforming. Vietnam's average age is under 25 years old, 28% percent of the population is urban, and they are urbanizing at over 3% a year. They are not alone in these very attractive demographics. Indonesia is arguably more promising in the near term. There is an inconceivable amount to be optimistic about. Would anyone here honestly claim that there has been more at any other point in history to look forward to? The World can and will grow without the United States; our humble pie has been baked and now lies in wait for us on the table.

If we must dwell on the what we are doing to ourselves in the U.S., I would like to point out that our unemployment rate at this trough is still better than that of France or Canada at their peaks. Those are two of the premier developed nations of the world.

Ken Drees comments:

If the incentive to park funds is removed, then a flood of available funds will be gushing into the hands of the public at most likely very low rates due to excess supply. And where does hot money go first–especially if business and housing are still on their collective backs? Stocks! So really why worry about deflation at all when it's obvious that a waiting flood behind a dam could at any time be let go.

You also seem to have optimism about large demographic countries and how our high unemployment mark is much better in respect to other countries. In contrast to this last night on Covuto, Donald Trump was most vocal about taxing chinese goods to the moon and taking all that revenue and paying off the deficit. He cited unfair business practices etc. Cavuto said "trade war," Trump said, "we need to get our best business people into positions of authority in regards to china trade policy and effect a hardline approach– after all the USA built them up to what they are now through buying their goods."

Change happens.

Jan

4

As one who, for a while, based all my market hypotheses on the importance of humor, I could go off for a very long time about it. Specifically related to stocks there is a relationship. However, I think that the study of birds is important to understanding humor (one subject of which I had desired to submit here some time back but immediately lost all my data, models, photos, video, and writings (and my dogs) when my girlfriend discovered my heart was for another girl).

Birds preferring groups, like pigeons, exhibit a useful behavior that I believe is a pointer to the origins of laughter. When observing pigeons for an extended period of time you will notice a repeating pattern. Typically when feeding on the ground, for instance, one pigeon will scare from a sudden movement of another and take flight. Most of the time all frantically join in flight and fly in circles a few times surveying the area for any real threat, and make their way back to where they were. They will do this over and over unless the threat is real, or the incentive for returning has been removed. They become more comfortable with a location with this process. Too much comfort and they start to just merely jump in the air and float back down, because after all, the place is safe. Is this “trusting the comedian”?

I was fortunate enough to be a few feet away from a large group in a park observing this "panic-exertion-calm" cycle as a hawk dove in on us. They were in the air before I even knew what was going on compressing the air around me with their flapping wings. Though I could tell it was different that time. After flapping full speed away over the lake in front of me they made lighting fast cut back. The hawk joined their flock, closing in on one. As fast as they flipped back towards me they reversed back to other direction, no circle here, and flew full speed out of sight. The hawk's target escaped by diving towards to the lake below while the group faked the move and continued away from me. Needless to say they never came back. It wasn't "funny" in the bird's equivalence of the word. I think this may point to the origins of laughter, and may explain its contagious attribute.

As a group creature a large portion of this animal's logic is based on the behavior of those around it. It makes up for what it lacks mentally by grouping. I think this is how they continually rationalize the safety of a location. Instead of incorporating many variables they merely use this “panic exertion calm” pattern as a way of giving them a feeling for the place.

People have a more complex method as we deal with many complex issues. Our intricate social experience necessitates the ability to chuckle off something that threatens our understanding of reality, an understanding we need to act out our roles daily. If someone jumps out and scares us we don't run around for five minutes to get over it, though if it’s scary enough we will. Laughter assists us in rejecting the negative association with the person scaring us and our environment. We logically understand we are safe, but chemically our brains are telling us we are in danger. Laughter gives us the chemical correction we need. If we don't, then an unhealthy sense of anxiety may develop and negatively affect our risk taking abilities (like going to the basement at night).

Many theorists on laughter believe that laughter is largely an ego driven behavior, many times used to assert our superiority over someone else's subhuman mishaps. Surely this occurs, but I believe that this is mostly using laughter to assert the status about ourselves to ourselves. It is one that the most insecure engage in: standing around making fun of people. Even this exposes the real purpose of laughter. This is a tool used to protect the whole person (which includes our sense of physical safety) and their social group. Here it is used in an attempt by someone to protect their own identity from incorporating characteristics of the people they make fun of (real or imagined). They neurologically reject the information (clothing, hairstyle, whatever) being presented to them. Teenagers are the best at this, and they are also the most insecure. They wield this tool cruelly because their self-identity is so fragile. Is a young up trending stock with many volatile swings insecure, but does that mean it is developing properly? I believe this is partly why teenagers and children laugh so much more. They are chemically rejecting certain behaviors or notions while having a good time with the exploration of their logical boundaries (small children).

The relationship of flocking birds returning to a location, laughter being used as a sentinel for what we incorporate as normal behavior for ourselves, social group, and society, and stocks is this: They are all based around a relatively trusted position and threats to that position. The structures of our personalities are obviously not fixed on a Cartesian plane, but they are still a mostly fixed structure at any point in time. Humor or laughter is an agent of plasticity. It seeks to maintain the status quo. It keeps the entropy of the social environment from making us gray. It preserves our direction. It doesn’t mean we whole heartedly reject the information per se. Laughter helps us induce a different view or information while safely maintaining our status quo. This is important. Our trajectory is determined in a symbiotic relationship between the short and long term. What we reject in laughter this time we may embrace the next. A dying rally can look like this.

Stocks have positions and direction of course. There are many ways to measure this. That brings up another subject entirely that I will avoid here as this already much longer than I had hoped. In equities most people are long so a sell off is generally a negative experience to a person holding, and possibly scary. Will the selloff be juxtaposition to the trend? Will it be a joke that only a few “get” at first? Then the understanding spreads to a wall of laughter across the audience? Conversely, will it be swift and unanimous?

Humor has a range of plasticity, or it is the range of which the plasticity occurs. A joke may be so far outside of the range that our logic can simply deal with it by becoming offended or simply recognize it as too much like our reality in a way that is simply not funny. Our social structures of the mind can deal with this incoming, unfunny, proposition. It did not get inside us and cause a problem with differentiation. We can reject it without exerting the correcting laugh that aids our logic in rejecting the small juxtapositions or subtle misunderstandings.

So like jokes, maybe there are ranges in stocks too which are digestible? Maybe it depends on the counter velocity and range relative to the longer trajectory? Maybe there is an escape velocity? Something that ensures it escapes from the constructs which laughter could heal. Escapes to a range where a different response would be needed; a sell off that actually needs to be sold into. Maybe at that point the rally, instead of the sell off is the joke; the frame of reference; the direction in need of preservation. Careful you don’t end up like those pigeons; too comfortable pecking at my seed while the hawk dives in.

What companies do people like? What will they decide is playing a good prank after a selloff occurs? Will a selloff and recovery reinforce their sense of safety or leave it weakened? Likewise for the “over rally”. How will that change the ranges you buy and sell? I dedicated much time building and studying various algorithms around this. It was worth it, though the fruit does not hang low and may not be plentiful if you lack resources as I do.